As rates rise, what should consumers watch for in their mortgages?

Singapore

SINGAPORE'S property market rebounded strongly after a slow first half of the year in 2020, with home prices hitting new highs into the first quarter of this year. This is despite Covid-19 casting a shadow over the broader economy.

A combination of factors may be driving this buoyancy: excess liquidity, desire for work-from-home comfort and record-low interest rates.

Still, home ownership and mortgage servicing remain significant concerns among young Singaporeans. OCBC's Financial Wellness Index 2020 found 55 per cent of millennials (aged 21-39) worried about not being able to afford a house for their own stay. Four in 10 (or 38 per cent) within this age group who already have mortgages have difficulties paying their loans on time.

This comes too as Monetary Authority of Singapore chairman and Senior Minister Tharman Shanmugaratnam just last week warned home buyers to think carefully about purchasing properties, as interest rates are rising in tandem with those in the United States, potentially ratcheting up debt servicing costs.

Strong economic recovery in the US has markets pricing in a Federal Reserve rate rise as early as next year. Singapore's economy is expected to grow between 4 per cent and 6 per cent in 2021, after shrinking 5.4 per cent in 2020 due to the Covid-19 pandemic.

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Prospective home owners should consider their needs, available savings and risk appetite. If they do so, the expected trend of rock-bottom rates creeping up can be managed, said mortgage brokers and bankers.

Those concerned with rising rates and who want peace of mind should consider fixed rate packages, which offer a flat interest rate, usually for up to three years. "In a recovering economy, interest rates tend to rise, so going for a fixed interest rate will allow consumers to hedge against the risk of rising rates," said Clive Chng, associate director at Redbrick Mortgage Advisory.

Floating rates tend to be lower compared to fixed rate packages, which means paying a lower monthly instalment. Such packages might be attractive to home buyers looking to save every dollar, but they then also bear the risk of interest rates moving northward. To be clear, in floating-rate packages, banks add a spread to the floating-rate used as a benchmark, to make the final rate charged to the consumer.

Wayne Quek, senior mortgage advisor at Home Loan Whiz, gave a concrete example. For a million-dollar loan, a 1.2 per cent fixed-rate package would translate to an annual premium of S$2,000, vis-a-vis a 1 per cent floating-rate package.

"For the home buyer, is it worth paying the S$170 per month premium to sleep better at night? Or would they rather take the risk and try to save this amount with a floating rate," Mr Quek said.

Another point to keep in mind is that Singapore is undergoing a reference rate reform. Home buyers opting for a Sibor (Singapore Interbank Offered Rate) package should note that the reference rate will transition to Sora (Singapore Overnight Rate Average) in 2024.

Sibor refers to the rate at which Singapore banks can borrow money from each other via the interbank market, while Sora refers to the volume-weighted average rate of unsecured overnight interbank SGD transactions brokered in Singapore.

Data from financial research platform ValueChampion showed the lowest floating rate pegged to a board rate stands at one per cent, while the cheapest rate pegged to Sibor is 1.22 per cent.

For fixed rates, the lowest available in the market is 1.23 per cent. The lowest rates as at April 8 are unchanged from the previous week.

In addition to interest rates, property owners and investors should also pay attention to the lock-in period. This refers to the time period - and this varies for each package - when a penalty would apply if one somehow wishes to end the loan earlier than agreed. That can mean paying off the loan in full, refinancing, or even selling the property.

Other factors to consider include the ability to prepay during the lock-in period, whether you are looking to sell the property for capital gains, and whether you hope to extend the loan tenures to improve on cash flow and capitalise on lower rates.

Those with existing mortgages should also review their loans to explore refinancing. Home Loan Whiz's Mr Quek suggested doing so four to six months before the end of the lock-in period.

Again, interest rates aren't the only things to consider. Instead, look at how potential savings from lower interest rates stack up against fees related to refinancing. These include legal and valuation fees, and sometimes penalty charges for early redemption, which may add up to a hefty sum.

OCBC's head of home loans Lee Mei Ling cautioned that those who have received legal fee subsidies may be required to pay back the amount if the loan is redeemed within the stipulated clawback period, which is typically 36 months.

Apart from refinancing with a new institution, you can also consider repricing with the same bank, which tends to be quicker and require less paperwork. Most banks charge an admin fee for repricing, which generally runs from S$200 to S$800.

As to how much buffer property investors should set aside to ensure that they are not overleveraged, Ms Lee pointed to the Total Debt Servicing Ratio (TDSR) framework, which mandates that the portion of a borrower's gross monthly income that goes into repaying monthly debt obligations should be capped at 60 per cent.

Financial institutions use a stress-test rate of 3.5 per cent, which means borrowers must maintain a TDSR of 60 per cent, even if interest rates were to rise to 3.5 per cent.

Maintaining a balance in your Central Provident Fund Ordinary Accounts also builds a buffer that is especially critical in the event of retrenchment, said Redbrick Mortgage Advisory's Mr Chng.

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